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P2-D2.
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kenshoei
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Below is one of the questions in BPP FR Practice & Revision Kit.
Creative accounting measures are often aimed at reducing gearing.
Identify whether the following measures will increase, reduce or have no effect on
gearing.Selling an asset under a sale and leaseback agreement
Increase/Reduce/No effect
The answer is Reduce.
As far as I am aware, sale and lease back leads to more debt (lease liability or finance liability depending on whether it’s regarded as sales or not).
This means debt as numerator and debt as denominator will increase by the same amount and therefore the ratio for this incremental portion is one.
So if the current gearing ratio is less than one, doesn’t this incremental liability leads to higher ratio?
P2-D2
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Hi,
You are right about the increasing level of debt but don’t forget that by changing the top and bottom number of a fraction by the same amount does not mean that things change in proportion.
Thanks
kenshoei
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